Q1 2024 Honest Company Inc Earnings Call

Participants

Elizabeth Bouquard; Investor Relations; Honest Company Inc

Carla Vernon; Chief Executive Officer, Director; Honest Company Inc

David Loretta; Chief Financial Officer; Honest Company Inc

Dara Mohsenian; Analyst; Morgan Stanley

Dana Telsey; Analyst; Telsey Advisory Group

Laura Champine; Analyst; Loop Capital

Andrea Teixeira; Analyst; JPMorgan

Aaron Grey; Analyst; Alliance Global Partners

Ryan Meyers; Analyst; Lake Street Capital Markets

Presentation

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Honest Company's first quarter 2024 earnings call. At this time, all participants are in a listen only mode after the speakers' presentation, there will be a question and answer session. Please be advised that today's conference is being recorded. I would like to hand the conference call over to Ms. Elizabeth Bouquard, Senior Director, Investor Relations at Onex Co., please go ahead.

Elizabeth Bouquard

Good afternoon, everyone. Thank you for joining our first quarter 2024 conference call. Joining me today are Carla Vernon, our Chief Executive Officer, and Dave Loretta, our Chief Financial Officer.
Before we start, I would like to remind you that we will make certain statements today that are forward-looking within the meaning of the federal securities laws, including statements about the outlook of our business and other matters referenced in our earnings release issued today. These forward-looking statements involve a number of risks and uncertainties that could cause actual results to differ materially. Please refer to our earnings release issued today as well as our SEC filings for a more detailed description of the risk factors that may affect our results. Please also note that these forward-looking statements reflect our opinions only as of the date of this call, and we undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements in light of new information or future events except as required by law.
Also during this call, we will discuss non-GAAP financial measures, which adjust our GAAP results to eliminate the impact of certain items. You will find additional information regarding these non-GAAP financial measures and a reconciliation of these non-GAAP to GAAP measures in the financial results section of today's earnings release. A live broadcast of this call is also available on the Investor Relations section of our website at investors dot honest.com. And with that, I'll turn it over to Carla.

Carla Vernon

Thank you, Elizabeth, and good afternoon, everyone, and thank you for joining us today. As we kick off the first quarter of 2024. I'm pleased to share that we achieved another quarter of improved financial results and solid growth momentum. As you recall during our last earnings call in March I shared several new achievements and announcements. These included key financial milestones we achieved as a management team in 2023, a new long-range financial algorithm and an updated strategic plan detailing our key drivers for long-term growth. We also reiterated our new operating mindset focused on our transformation pillars. Ddi's pillars, brand maximization, margin enhancement and operating disciplines are deeply rooted in our enterprise practices, and they will remain an enduring strategic component of building a stronger financial foundation and unleashing the full potential of the honest brand. These pillars have enabled us to strengthen our business performance, our operating culture and our financial results. This quarter's notable financial achievements include delivering a second consecutive quarter of positive adjusted EBITDA and reaching revenue growth in line with our outlook, marking our eighth consecutive quarter of positive year over year revenue growth. We also achieved a gross margin of 37%, which is a record high for our time as a public company and is an improvement of nearly 1,300 basis points year over year.
In addition to these financial highlights, our brand continues to grow in the number of homes and people, we are reaching our last 52 week household penetration is 6%, which is up 18 basis points year over year as we begin on the path of executing our long-range strategic plan. Our growth with new consumers and new households is delivered through a blend of increasing availability, maximizing our hero products and delivering meaningful new product innovation our wipes portfolio is emblematic of the strategic building blocks that will drive our long-range growth strategy. Our wipes business grew 44% in consumption in 2023. We're pleased this growth was driven by a combination of strong performance across our core items and successful innovation launches, including flushable wipes. Our early indicators of our successful launch into flushable wipes underscore an important principle of our long range strategic growth plan. We continue to see that the honest brand can successfully travel across consumer age groups, usage occasions and even parts of the home. As I look out to 2024 and beyond, I continue to remain confident in our ability to further amplify the distinctive elements of the honest brand and meet the growing consumer demand for a higher standard of clean ingredients in baby and personal care products. With a clear vision for the future, we will continue to advance and scale honest, trusted products and our business model through the power of our brand, our team and our honest standard. And now I will turn it over to Dave to share the financial details of our first quarter and outlook.

David Loretta

Thank you and welcome, everyone. As Karla noted, we are off to a solid start in the first quarter, giving us confidence in our newly articulated strategy moving forward, we have continued to make progress on improving profitability while maintaining revenue growth. The significant expansion in operating margin is the result of two drivers. One, meaningful improvement in gross margin of 37% this quarter and two diligent management of operating expenses, which leveraged 810 basis points over Q1 of last year. We remain confident in delivering the stated results for 2024 and executing our long term strategy with a clear focus on building a stronger financial foundation.
Before I dive into financial results. However, I wanted to address the changes we made in our revenue reporting structure. We have transitioned away from our prior disaggregated revenue categories and channels to align our reporting structure with how we operate the business and what impacts the timing of our cash flows. We will continue to provide the percentage of revenue from honest.com in our 10 Q given the difference in cash flow timing versus our third party channel.
Now let me dive deeper into our first quarter results. This quarter through our brand maximization pillar, we delivered revenue of $86 million, up 3%, driven by distribution gains and strong velocities across a number of key products, specifically baby apparel, wipes and baby personal care. We continue to grow the honest brand through balanced revenue growth of unit volume and pricing. Notably, our total Honest Company ACV or all commodity volume increased to 85% versus 78% a year ago. Our Baby business demonstrated strength across two key areas this quarter, baby apparel and baby personal care. First, our baby apparel business has emerged as a key growth driver as a result of distribution expansion in brick and mortar stores, along with consumption growth of 41% at our leading online retail customer.
Second, we are pleased with the growth of our baby Personal Care portfolio that has now become the leading baby personal care brand in our largest brick and mortar retail customer.
Turning to our second pillar of margin enhancement, gross margin in the first quarter was 37%, up 1,275 basis points from last year and up 350 basis points sequentially. Key gross margin drivers included product and supply chain cost savings, pricing and trade promotion efficiency. With our continuous improvement mindset, we realized savings across product cost, logistics and fulfillment. As a reminder, the sizable gross margin improvement includes certain one-time inventory write-offs related to the transformation initiative in 2023 that amounted to roughly 400 basis points. The remainder of gross margin improvement included approximately 600 basis points in cost savings, mostly as a result of renegotiated product and logistics contracts and 275 basis points in pricing.
Operating expenses decreased $6 million in the first quarter compared to last year, reflecting lower SG&A expenses and improved marketing efficiency. Sg&a as a percentage of revenue declined 500 basis points compared to last year. As we remain focused on ongoing expense management. Our operating discipline pillar represents our commitment to generating improved bottom line results and continued strengthening of our balance sheet. Adjusted EBITDA for the first quarter was positive $3 million compared to negative $10 million last year. This is our second consecutive quarter of reporting positive adjusted EBITDA and supports our path to profitability. As we have now achieved positive adjusted EBITDA on a trailing 12 month basis.
On the balance sheet, we ended the quarter with $34 million in cash, an increase of $22 million versus last year and zero debt outstanding. This represents our fourth consecutive quarter of positive operating cash flow. Our cash position continues to benefit from a capital-light business model and diligent management of working capital. Overall, our first quarter financial results support our continued confidence in our long-term strategic plan and our outlook for 2024. Therefore, we are reaffirming our full year 2024 financial outlook. That includes net revenue growth of low to mid-single digit percentage and positive adjusted EBITDA in the low single digit to mid single digit millions range combination of the strength of our team. Our focus on operating discipline and healthy Q1 results give us growing confidence in the mid digit portion of our range in both revenue and adjusted EBITDA. We will continue to closely monitor and react to any changes in the macro, economic or consumer environment. We are pleased that these three transformation pillars provide us a clear framework for defining and measuring our growth road map. Along with our strategic growth plan. They define and guide our building blocks for growth and our operating approach together, they enable us to deliver improved financial results and long-term shareholder value creation through a stronger and more scaled honest brand and Company.
And with that, I will turn the call over to the operator, and thank you.

Question and Answer Session

Operator

(Operator Instructions)
And our first question comes from Dara Mohsenian from Morgan Stanley. Your line is now open.

Dara Mohsenian

I guess, first, just a clarity question. Why maintain full year guidance given the Q1 upside to some extent that applies to revenues, but particularly EBITDA, given the strong profitability in Q1, is that just conservatism as it early in the year? Or is there something about Q1 that that comes out of the balance of the year? And then Karla, maybe just given an uncertain consumer environment, can you discuss if you think you're seeing any impact on consumption for your products from any consumer pressure, trade-down impacts on your business and perhaps give us an update for how things are trending so far in Q2?
Thanks.

David Loretta

Yes, hi, Dara. This is Dave here. Thanks for the question. And albeit certainly we're pleased with the first quarter results. We're off to a strong start this year on both a pleased with the top line, but about even the margin expansion was all all kind of elements working together as we are as we brought forward. So pleased with that now and looking at the balance of the year, certainly we want to be a little bit cautious from any uncertainties out there. And it's early it is really just a function of it's early in the year and and we're cautiously confident that's up. That range is the appropriate range. As I did highlight in my prepared remarks, some leaning towards the mid side of that of that range is where we're gaining confidence in the next couple of quarters really will will give us a clear road a road map there but I am so we'll come back at the next next quarter to update any changes we've done.

Carla Vernon

Hi, Dara, this is Karla, and I hear your voice. Thank you for joining our call. And your question for me was really what am I seeing in the landscape of the categories we play in? And do I feel like there's indicators from any of the external trends or consumer indicators that concern me. And I will say that on this are the results you're seeing are driven by uniformly strong consumption for us across our category portfolio. The real confidence builder for us in the quarter is that if you look at the way our growth shaped up, we were able to actually grow year over year on a combination of unit volume and pricing as Dave covered in his remarks. So I think what that really shows us is, but the honest brand is very strong and resilient, even in these times because the benefits we offer for clean personal care and baby have such a meaning and our brand is such a demonstrated leader in this area on top of really strong execution by the team, knowing how we need to deploy the way we support the brand. It's working very well for us.

Dara Mohsenian

Great. And then, Dave, if I can slip in one follow-up, just the gross margins were obviously very strong in the quarter, well above what the Street expected. It sounded like most of the drivers you mentioned year over year were more sustainable. So can you just talk about that gross margin line and how sustainable the Q1 level is as you think about the go forward over the next few quarters?
Here? Thanks.

David Loretta

Yes, certainly, as you said, that the gross margin drivers, we're a big element of what we saw is the improvement this quarter, and we did call out that improvement over last year benefited from the prior year's write off due to the transformation initiatives, so roughly 400 basis points and benefit there. But the remaining amount is a function of costs, cost management on product fulfillment, logistics and the benefit of pricing. And so if you think about our outlook and driving earnings growth, it will come from a combination of increased revenue, but also the expansion of of gross margin and Q4 are 35% related to a pretty healthy increase in Q1 37%. So we're comfortable within this range and see that that's where for the balance of the year, we'll still see meaningful improvement over the prior year, which gets sequentially more tougher with the comps. But but we're comfortable in the range that we're at.

Operator

And our next question comes from Dana Telsey from Telsey Group.

Dana Telsey

Hi. Good morning. Good afternoon, everyone.
As Carla. As you think about the distribution channels and your categories, what changes are you seeing in distribution channels, what changes are you seeing in orders? And then as you think about pricing go go forward, what lever on the gross margin does that play going forward as compared to what happened this quarter? Thank you.

Carla Vernon

I think you again a nice to be with you today. Thanks for joining the call or for yourself on those parts and distribution. As you pointed out, distribution is such an important part of our overall road map for growth. We articulated in our recent investor presentation. These three pillars brand maximization, margin enhancement and operating discipline, and that distribution piece really live for us in that brand maximization pillar, and it's actually been a very strong driver for us. As you may recall, we moved from 78 ACV into the mid 80s this year and our our distribution growth in the quarter. We also grew 9% within the quarter in distribution. So we're very pleased at the early stages of really delivering on our overall distribution strategy, which internally we have this short hand, we call it our spaces, places and spaces strategy because there is so much fundamental growth for us available on distribution. That distribution is actually driven not only by getting into a new door, but by increasing the product offerings available in our PRO portfolio. So for example, this year we executed a couple of really strong sizing strategy launches. We launched our tabletop refills for our very top selling the personal care by washing shampoo line. We also launched a large size of our KeyLink appointment by being able to bring our hero items forward in larger sizes, we're really able to bring distribution on proven hits to our retail channels in our current aisles. So we're very pleased about the early days in which we are executing our distribution strategy, and we continue to expect that to be a leading driver of our scaling of the honest brand, you know, about pricing. We have seen our pricing be effective in market that we that we put in place over the last year, which broadly was across almost all of our categories. As I just said, for the last 12 weeks, our growth is really nicely balanced between unit growth and dollar growth. So we feel comfortable that our pricing is being accepted and then where placed pricing plays a role in the future, it will be something we will always consider based on what we're seeing in our relationship with the categories where we serve a role as a premium brand and what we see as the sort of consumer macroeconomics.

Operator

And our next question comes from Laura Champine from Loop.

Laura Champine

Thanks for taking my question. It's a follow up and congratulations on especially the EBITDA performance. It does seem like a lot of the improvements you've made on profitability are structural. So it's if you were to turn to a negative EBITDA in next quarter or bid some quarter this year. What would be the most likely drivers of that downturn? Would it take and sales decline? What would need to happen for you to get back into EBITDA, adjusted and double. Mike?

David Loretta

Hi, Laura. Thanks for the shout out on the progress on EBITDA. We're happy with that. And we know that that's kind of a function of executing well across the team on a number of those fronts. So structurally, the they are they are really becoming grounded in the business model of success. So I would say that the guidance that we've given is and adjusted EBITDA low to mid single digit millions still gives us room to see improvement each quarter. And at this stage with so much balance of the year in front of us. And we're just we're going to keep working through all of our plans and trying to replicate and execute as fast as we can. So I don't think I think that's that's the confidence that we've got. But I kind of leave it at that point. And I and Avesta sort of reflect on that.

Laura Champine

But let me try to rephrase in a way that's a little less guidance and CFO oriented and get a bigger picture view.
And maybe, Carlo, if you think about your business, what are the risks that you're watching out for right now, especially as it might impact your profitability.

Carla Vernon

And Laura, so that. Yes, well, I'm going to be honest with you that we've been on this really consistent path of improving ourselves quarter-by-quarter. And that strength in performance is really based on our team coming together well, over the last year, we brought people with great expertise but intentionally a variety of experiences and expertises. And I'm so proud of how we've been executing. And so as we look ahead, I really think we're even continuing to have the discipline internally to make sure that we understand how to deliver on this plan and how to be nimble in the event of change. However, I would say, you know that the things that we don't control. I really I can't kind of even predict or comment on the things we don't control. What I do know is that the plan we have articulated in reconfirming our guidance for the year is something we feel strong about because of what we know we have in front of us and what we see as our drivers. So I think we all have to be on the lookout for consumer and macroeconomic trends or any kind of unpredictability that would probably not only affect us but would affect others in our sector and our segment, what was what is within our control? I think the reason we're reporting we feel confident is because we really like how we're executing.

Operator

And our next question comes from Andrea Teixeira from JPMorgan. Your line is now open.

Andrea Teixeira

Thank you, operator, and good afternoon, Carla, Dave and Elizabeth on so far, just wanted to ask well for fresh out. I hope you're all well, and congrats on the performance following up on Dana's question on distribution I was wondering if you can give us a phasing of the comps of extra distribution extra on the additional distribution you used you got last year and into this year and if at all, we should be mindful of the lapping of those gains? Or are you seeing velocity and innovation offset that? And if you can also comment on what you're making Dave, you just said about being conservative at this point. Are there any reinvestments you may need to make as you get more distribution or perhaps, you know, incorporating the changes in the license agreement with GSK pharma or incorporating any on this chart, I understand that you would be positive for margins long term, but if you on is there any short-term impacts adjusted EBITDA that offset the strong start of the year? Thank you.

Carla Vernon

I think we have a divide and conquer here and let me start by talking about how our distribution has been up kind of our glide path there. And I know you're asking about investments. I would love Dave to talk to you about how we're feeling about investments and what we think we're going to want to do there on. And so what I would say about distribution, and I think it's something we've discussed on our previous quarters. We are we're very successfully. As you guys know, the shape of our portfolio is very strongly balanced as a combination of brick-and-mortar and digital. And we are so pleased with the way we've been able to deliver growth.
Oh, my sorry, my kids are texting. They always get through the do not disturb living on my phone off the table. I'm sorry about that. And so we're very balanced digitally and brick-and-mortar. But brick-and-mortar is really the distribution that you see show up when you see these big distribution changes for us. And it is also where we are less distributed relative to our competition. And so while much of that distribution was actually new in 2022 for us in a big tranche at getting into Walmart as we saw that those gains happen in 2023. There was a little bit more of a uniform glide path. But I would say that distribution, when you're doing it in a brick-and-mortar context across as many categories as we have can have periods where there will be strong one-time gains. And then we want to see ourselves settle in and drive velocities from there. So it's always going to be a mix. It's not going to be the same rhythm in any given time period, but we know that we've got an enormous runway for growth on being in more doors. Remember, we only got some of our inventory at 50% of the Walmart, while some of our inventory was at 100% of the Walmart. We also know that even our hero items, some of them have distribution as low as 20% and 30% ACV individually. So we also know that while we are in at some retailers, we are looking to get stronger shoulders, if you will, across the board and that that's going to come at different time period with the different resets. So it might it might occasionally be a little bit lumpy. But overall, on a year-by-year basis, we look, we like the outlook.

Andrea Teixeira

And Carl, if I can sneak in just one comment on that. So obviously, you've done amazing at BofA clicks and bricks. You are it says your tracked channel consumption was up seven. Wondering if you can help us with the non-tracked and since you grew sales by three, so it kind of implies that was a 400 basis points headwind to your to your revenue. Is that any are destocking or and if so, is that over?

David Loretta

Yes, Andrew, let me maybe just address that last point. On the revenue side, the 3% growth over prior year. We still as we called out last quarter, there was some shift in order flow into the fourth quarter that that accelerated that period's net revenue, which was 10% up. And normally those orders would have been in the in the first quarter. So so that sort of helps bridge any any difference in what you would expect within that within the tracked channel progress. But let me kind of revisit the EBITDA and the flexibility that we've got there. And this is really the the benefit of the business model that we're building here is it's flexible in its nature we're not encumbered with a lot of fixed overhead and capital expenses. And the flow through, in particular on revenue down to the bottom lines was quite notable. And once the structural changes in the product cost. And then fulfillment and logistics costs are now really working working well, but also save part of the EBITDA benefit in the gross margin benefit this quarter.
Was some trade promotions were lighter than we would normally have them in the quarters, and that helps flow through gross revenue to net revenue. So we will see a trade promotion activity and marketing investment and expenses flexible in future periods that can that we can drive some of the momentum and keep it going through the to the balance of the year.
So maintaining that flexibility on those two fronts is something that we that we want to keep in front of us and and we'll use it in the right moments to really keep that top line momentum. Hopefully that helps.
And I think the question around the NIL., you know, we as we shared, there's a transition plan, but any costs to kind of make adjustments to two under that separation agreements, our fully factored into our outlook. We don't expect any incremental from beyond our outlook plans for expenses to make that transition and frankly, the transition sort of been in motion over the last 12 months anyway. So it will it is a big impact on the product in the stores.

Operator

And our next question comes from Aaron Grey from Alliance Global Partners. Your line is now open.

Aaron Grey

Hi, good evening and thank you for the questions. So first question, may want to go off the back of the last one and just to get a better color in terms of how you're thinking about letting some of the on top of that flow through the bottom, especially in the back half that you're looking for more top line growth you kind of touched on it there, Dave, in terms of having that lever in terms of trade promotion and marketing. So is it fair to think that maybe you kind of push that lever a little bit more on the marketing and trading the back half to drive growth longer term rather than let it flow through the bottom line versus letting it flow through and maybe come in at the higher end of our guidance is today, just in terms of how you think about that would be helpful.
Thanks.

David Loretta

Yes, I mean, we've got marketing plans in place today, but there's also a lot of flexibility because of so much of what we do spend in the media content side is digital. And that's in that short term. And so we have the ability to kind of dial it up and dial it down based on return on ad spend. And we like having that that flexibility during different periods of events that we've got planned with retail partners and to drive in our digital channels with our online retailers. So it will be it will be a flexible aspect to the model that we see going forward. But again, fits within the guidance that we've given and even leaning towards kind of the mid side of that guidance as I shared on my remarks from so pleased with the progress we're making to execute at this stage.

Aaron Grey

Okay, great. Thanks for that.
And same question for me. Just in terms of some of the initiatives you have in terms of packaging specifically, can you give us any update in terms of some expectations there?
Have you guys done any types of pilots or what we could think in terms of some changes on packaging for some of your SKUs going forward? Thank you.

Carla Vernon

I love this question. So thank you for asking, and it's really great to hear from you, Aaron. So appreciate that we are packaging is really an important part of our brand maximization pillar, and I am so pleased with the fact that we that you know, we have key partners, our Chief Growth Officer and Jonathan Neely as our Head of Sales. And between the two of them, they've been really collaborating strongly on how we update and upgrade our packaging as a key piece of our marketing pillars. That uniform packaging update is something that we want to be making sure is strong across our portfolio and over the last year, the team has been working diligently to iterate on the packaging to conduct both quantitative and in-store physical in-person qualitative analysis with several rounds because I would say for those of us that are alumni of some of these great CPGs that we are in. We understand our power of packaging as your lead marketing vehicle for, especially for a brand like ours as well as the importance of getting it right. So I would say that I'm able to talk about it because we have done some of the packaging tests now actually physically in our top brick-and-mortar retail stores with A/B testing and different versions. And some of the updates are going to be really fantastic. One of them that we've been talking about a lot is making sure that, you know what's inside the boxes from here forward. That's been a key area. There's a very exciting execution that will be introduced into the market. And it's going to I see it's going to make a big difference in making the products more shoppable for consumers, especially in our skincare, beauty, Beauty Care product lines.

Operator

And our next question comes from Ryan Meyers from Lake Street Capital Markets.

Ryan Meyers

Your line is now open and guys, thanks for taking my question and congrats on another solid quarter. I'm just wondering if there's any way that you can quantify new customers that you were able to add during the quarter?

Elizabeth Bouquard

We're jumping all over each other to answer that. You know, there's a few ways we think about that one of them is really recounted in my remarks. So I with talking about the success in the quarter, especially the revenue growth that we've seen, that's really driven by expansion with in distribution and expansion by our buyer base.
The household penetration information that I shared you may recall in the script, I indicated that this quarter our household penetration was up 18 basis points.
Also, if you look to our investor presentation that is on our website, we published a new investor presentation last fiscal quarter at investors dot honest.com. There's some information there that talks about looking at some of the new household growth, specifically in our we engage with a retailer really pleased last quarter, we reported that we quadrupled the new-to-brand household users on Amazon for on it and is a former Amazon alone. Myself. I can tell you that pulling new people into your order pattern is a really high traction way to grow. So we have a lot of indicators that make us feel good about that.

Operator

And I'm showing no further questions. I would now like to turn the call over to Karla for closing remarks.

Carla Vernon

Everybody, thank you so much for joining in and being with us today. It was a pleasure being with you. We look forward to speaking with you next quarter and can't wait to reconnect. Thank you.

Operator

This concludes today's conference call and thank you for participating. You may now disconnect.